So, here is what seems to be happening in my best layman’s terms. The businesses in our economy are not selling enough stuff because we are not buying enough stuff.
The businesses are not making enough profits and some are even making a loss therefore they decide to cut their costs which in some cases results in making people redundant. Those businesses then cut costs and increase their profit but the income normally received by the people made redundant is no longer out there being spent on other businesses.
The economy as a whole shrinks – businesses don’t want to take on new staff, develop new things for us to buy or take risks with new ventures. Ordinary people are nervous about their jobs and future income and so keep their money rather than spend it, further reducing the likelihood of stuff being made and sold.
Banks, who normally create more money by lending money to us at various interest rates through mortgages or personal loans, are nervous about the level of “bad debt” they own. To counteract this bad debt they want to keep as much good money on their accounts (in the form of our savings and deposits) and are extra nervous about creating any more bad debt by lending to people like you and me.
But the economy and the businesses which support our income and fill the government vaults with taxes need us to purchase their goods and services. So the Bank of England has dropped their interest rate consistently to help pump more cash into our hands. Anyone with a mortgage linked to this rate will have seen some extra cash in their bank account over the last period. Perhaps we have used this to buy more iPods, food or holidays but equally we might have just put it back in the banks as savings or paid off more of our mortgage debt. So, some of the rate drop “works” by increasing the purchasing of stuff but in other cases it just stays in bank accounts or reduces our personal mortgage debt. If these rate drops don’t do enough then the Bank needs to come up with additional options to get cash swilling around in the economy – getting more money to us in such a way as to make us feel “flush” enough to spend on the goods & services our businesses want to sell.
So the latest trick is “Quantitative Easing”… dealt with in part 2
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